Carbon pricing is planetary Russian Roulette

How much would you have to be paid for each bullet loaded into a gun in a game of Russian Roulette? A runner-up in the Ecologist/nef essay competition...

How do you price the tonne of carbon that, once burned, tips the balance and triggers catastrophic, irreversible global warming?

This question is phrased to give scope for only one answer: there is no price and therefore carbon markets are pointless.

It is similar to the question 'have you stopped beating your wife yet?' There is no answer. Any answer would probably fall into uninteresting categories such as, 'the price is irrelevant because it is infinite', or ideological such as, 'carbon markets cannot work'.

The question’s value is based around studying the context within which it is framed; how effective is pricing in carbon markets? What type of process is climate change and what can we know about it? This essay focuses on pricing carbon and how this can connect to a complex process like climate change.

The more general question, 'how do you price a tonne of carbon?', is as slippery as the question about the tipping point tonne of carbon. Price in economics is simply a mechanism to collect relevant information (cost of inputs, supply, demand etc) about a product so a buyer and seller can trade. The price then signals to the market what is scarce and what is abundant so the market can then allocate resources 'efficiently', e.g. reduce carbon consumption and increase renewable energy.

However prices are almost always imperfect for a number of reasons, ranging from lack of information to ignoring costs such as pollution. If prices are imperfect then the concept of efficiency in markets is pushed even further into academic irrelevance. In the case of carbon there is an even more fundamental pricing flaw: it ignores the concept of extinction.

An extinct argument

To explain how economics ignores the possibility of extinction and to provide a human perspective on pricing I would like you to imagine you are about to play a game of Russian roulette. You are loading bullets into a gun for the game and the question is, how much would you have to be paid for each additional bullet inserted into the gun?

Most of us would not accept a payment for even a single bullet in a chamber, let alone, as the title of this essay asks, the price of the final bullet which fills all chambers. There is no mechanism for pricing in this situation because the outcomes are so asymmetrical: extinction or cash.

Given this position how does the economic price of carbon collect all the relevant information to send a signal to the market? Pricing at the tipping point is irrelevant because we have no idea what the price would represent and hence how it would change behaviour, and with catastrophic asymmetrical outcomes (death or cash) asking for a price is similar to requesting a medic for someone already buried.

We can extend the Russian roulette analogy further to identify an even bigger issue than price. At the moment humanity has mistaken this for a game of Russian roulette with a water pistol. All we are doing is upping the pressure in the water pistol so losing is simply being sprayed by water at a higher pressure. This is a more fundamental issue than price: how to convince people who are wealthy, comfortable and lazy that they need to make fundamental changes.

Forecasting the unknowable

This brings us onto the second part of this question, what type of process is climate change and what can we know about it? We need clear answers to these questions to convince people that climate change is a real gun not a water pistol. Unfortunately this is where we run into the limits of human knowledge, in particular the ability to forecast complex dynamic systems. Science has expanded many areas of human knowledge enormously over the last 2,000 years, however, forecasting dynamic complex systems, such as the earth’s climate, is not one of these areas.

This is supported by numerous theories, but I will select just two. The theory of unintended consequences states simply that whatever we do in a complex system will have a range of consequences we did not intend and could not forecast because of our lack of knowledge.

Another currently vogue theory is the 'Black Swan' by Nassim Nicholas Taleb which, crudely put, is that the most important events in the future are the largest events and these we cannot forecast. For example the current financial crisis is huge and was not forecast, otherwise banks would not have lost trillions. If we cannot forecast the future with any certainty how can we convince people of this very real threat? We know that our climate is changing but we cannot know with any precision what will happen or the severity of the changes, therefore discussions of tipping points and the future are interesting and useful but only to support a moral theory, the precautionary principal. If we do not know all the consequences of our actions but we now they may be severe (e.g. the death of our planet) then we should hold off until we know more.

Whither the carbon market?

With the price of carbon at tipping point irrelevant in a Russian roulette situation and almost zero capacity to forecast the future in a complex system, where does this leave carbon markets and the immediate requirement to change people’s behaviour? Three factors need to be recognised: we are simply evolved biological creatures with all the inherent drives of nature (sex, hunger, greed, happiness etc) and the veneer of civilisation is very thin; secondly we have a long history which has left us with a huge infrastructure legacy based around carbon consumption and thirdly; power and vested interests represent massive inertia in the current system. Our answer to climate change has to take into account these factors, as well as biology, history and money, and hence this precludes the precautionary principal.

Answering difficult questions on this scale requires trying many different solutions quickly and in parallel to learn what works and what does not. Initially changes will have to take place within current social frameworks, including markets, and within the limits of our knowledge. Given this context it would be stupid to discard carbon markets provided they are considered as only one innovation amongst many other areas which require innovation including education, law, business, technology etc.

The price of a tipping point tonne of carbon is not of interest; however, a price on carbon must form part of our learning process to work out the best solution, otherwise we will find a real gun in our hand all too soon.